Home loans using crypto as collateral: Do the risks outweigh the reward?

“I’m never gonna bother with that bullshit again,” says Bitcoin OG Michael Tozoni about getting a crypto home loan to invest in property.

After becoming wealthy-ish with Bitcoin investments, Tozoni sensibly decided to diversify. Not wanting to sell off his crypto, he had grand plans to borrow to buy investment properties and use the rental income to pay off the loan.

The only trouble was that banks aren’t the slightest bit interested in wealthy Bitcoiners, preferring poor wage slaves instead.

“If you are broke and you have no money, but you have a job and a constant income, banks will be very happy to give you money,” he says. “If you have a lot of money and a lot of investments, but no income, banks do not want to give you money.”

While Tozoni eventually found some traditional lenders willing to provide him cash, he crunched the numbers and realized that the interest on a Bitcoin-backed loan was cheaper, at least in his particular circumstances. Looking back, this was probably a mistake.

Tozoni is the poster boy for the typical Bitcoin-backed loan customer, according to Adam Reeds, CEO of Toronto-based crypto lending firm Ledn.

“Bitcoin-wealthy clients that have been turned down from services at legacy financial institutions” is how Reeds describes the cohort.

The idea of putting Bitcoin up as collateral for properties intrigued Tozoni, as he’d be able to purchase investment properties and keep his Bitcoin.

The only trouble is: It’s risky as shit. 

How crypto home loans work

Here’s the lowdown: Instead of selling your Bitcoin for cold hard cash to buy your dream home or investment property outright, you can stash it away as collateral with a lender.

It’s pretty much an agreement with the lender that says if things go south, worst case, they keep your Bitcoin.

If and when you pay your loan off, you get your Bitcoin back.

So far, so good, but the loans come with a massive catch — if the value of your Bitcoin collateral goes down too far, it gets liquidated.

That means Bitcoin’s wild and unpredictable price swings make this a high-risk, some-reward-style scenario compared to traditional mortgages.

While mortgages backed by banks only require a 10%–20% cash down payment, most crypto collateral loans start at 100% of the loan value, and some require 200%.

Meaning, at the minimum, you are going one-to-one with the loan, so if you have your sights set on a $600,000 loan, be prepared to lock up at least $600,000 of your precious Bitcoin.

If the price of Bitcoin decides to take a nosedive, while you’re conveniently out of phone reception, you might miss the margin call urging you to top up your collateral. Or you might not have enough extra funds to cover it. 

If that nosedive turns into a full-blown swan dive, then bam, your Bitcoin collateral disappears as quickly as a magic trick, otherwise known as liquidation.

So, how did it work out for Tozoni?

He says, “It started out kind of okay,” as the first properties “made a grand here and there, but then it just went downhill” as the COVID-19 pandemic kicked off.

He selected a 200% collateral ratio, meaning his lender held the power to instantly liquidate the collateral if its value dropped below “115%–120%.”

Tozoni says it required constant monitoring of Bitcoin’s price, from breakfast to dinner.

“If it gets down to 170%, you get a margin call where you have to deposit more money. If it gets down to 115% or 120%, it’s instant liquidation. So, they just dump it right away in order to be able to cover their amounts.”

Risks of crypto home loans

Reeds explains that this is the biggest concern that Ledn’s new clients have before signing up for a Bitcoin-backed loan: What happens in the event that Bitcoin’s price drops, and how much time will they have to come up with the additional collateral?

“If the price of Bitcoin drops by more than 50% from the time they took the loan, the client must top up the Bitcoin collateral to maintain the loan in a healthy status,” he says.

While Ledn’s Bitcoin mortgage product allows two weeks to post additional collateral, the “standard Bitcoin-backed loans are programmatic, and margin calls need to be met before reaching the liquidation threshold,” Reeds explains.

Unfortunately for memecoin hodlers, the only digital asset that Ledn accepts as collateral is Bitcoin, with the collateral ratio “set at 100% of the value of the property being mortgaged.” Its home loans are currently only available in Ontario, Canada, but it plans to expand to other provinces and some U.S. states later this year. Mortgages are also only for two years before being assessed and renewed.

Jarrad Parke, chief operating officer of Australian firm Black Tie Digital, says that collateralization is the No. 1 topic new customers want to try to understand. “What surety they have that their digital assets will be returned to them,” Parke says. The firm acts as a broker for those looking to get a crypto-backed loan.

In Tozoni’s case, he opted for a “two-to-one collateral” strategy, aka 200% collateral, meaning he had to deposit twice the amount of Bitcoin he wanted in the equivalent value of traditional fiat cash.

“If I wanted to borrow $100,000 [in cash], I had to put down $200,000 in Bitcoin,” he says.

Parke says that people who have Bitcoin should understand that “if you’re holding digital assets, you’re holding assets – full stop.” 

He emphasizes that one of the biggest barriers to entry for most people is the ability to save the deposit. It is pointed out that “crypto has allowed an ever-increasing number of people” to short-cut through this process.

Like any investment lending decision, it all comes down to risk.

Parke says the collateralization rate “is primarily driven by the size of the loan and the length of the term.”

Although its lending partners are the ones who decide what digital assets are able to be collateralized, Parke explains that “generally, low market cap tokens, highly volatile tokens and the like aren’t accepted.”

“BTC and ETH represent almost 2/3 of the total market cap. We generally find most significant holders of digital assets are covered.”

Advantages of a crypto home loan

Some people have had good experiences with Bitcoin-backed home loans. Max (not his real name) tells Magazine he’s happy with his crypto mortgage organized through Ledn for a “very unique property” as an investment. 

Max took the Ledn option as legacy banks are “really bad at taking digital assets as collateral.” The crypto mortgage means he’s been able to hang onto his Bitcoin in expectation of future price gains. He also avoided a nasty capital gains tax bill that would have resulted from selling off Bitcoin to buy a property outright with the profits.

“I want to take advantage of fiat debasement. I don’t want to realize capital gains, and I believe Bitcoin will continue to average 50% YOY.”

Max warns anyone considering this loan option to conduct their own due diligence and “calculate risk correctly,” as price drops can lead to a dreaded margin call. He says he is yet to experience one.

Max sees a bright future for crypto-backed loans, believing that Bitcoin hodlers will especially find value in the product.

“Bitcoiners are very capitalized and will start to want to take advantage of it without selling,” he says.

30-year crypto mortgages with Milo

There’s no official history of crypto-backed mortgages to rely on, but it seems as if Nexo was the first platform to offer large crypto-backed loans back in April 2018, providing enough funds to buy a house.

Since then, a small number of specific crypto collateral home loan providers have appeared, including fintech companies Milo and Figure in 2022 — though Figure seems to have been telling prospective customers to join the waitlist for over a year now. 

Milo’s announced its world’s first 30-year crypto mortgage product in January 2022.

“Clients will be able to finance 100% of their purchase with no dollar down payments required and do this faster than a conventional mortgage,” it said at the time.

Mortgages are available to purchase property worth up to $5 million at a 9.95% rate, collateralized with ETH, BTC and USDC. The product is only available for properties in the United States.

Within three months, Milo announced that it had closed a “record $10 million in crypto mortgages.”

In comments to Cointelegraph in 2022, Milo said that its customer base was mainly Bitcoin and Ether hodlers who wanted to get a loan, while they kept on hodling.

It said the market turmoil had made potential clients more wary. 

“We have definitely seen that consumers are requiring more transparency from the companies that they engage with. This has given us an opportunity to see how we improve our solution even more in this period of time. We are still seeing demand from consumers that want our unique solution.”

Josip Rupena, CEO of Milo, updates Magazine via email for this story, saying the total value of crypto-backed loans written has now risen to “around $17 million,” and the firm has yet to liquidate a client’s cryptocurrency.

“We have not issued any margin calls, and all of the clients that have worked with Milo have made $ on the appreciation of their Bitcoin or Ethereum.”

Which raises an interesting point. While a crypto price plunge could see users wiped out, a crypto price rise could see the loan progressively more and more overcollateralized.

Will the big banks offer crypto mortgages?

Crypto winter has taken a lot of the heat out of the products this year. Investment bank Citi released a report in June 2022 saying that crypto mortgages were gaining prominence, despite it being “rare to find new types” of mortgages in the post-GFC U.S. finance market.

The report notes that crypto mortgages offer tax and liquidity benefits for both customers and borrowers.

“The core idea of protecting from capital gains tax and a more liquid reserve account for credit exposure can potentially be mutually beneficial to both originators and borrowers if the financial assets in question were stable and liquid.”

“Allowing crypto investors to utilize their investment gains to secure a loan without incurring the tax event and loss of further upside if they were to liquidate said cryptocurrency into cash,” it says.

However, due to the highly volatile nature of crypto, it notes that this loan might not be a viable option for everyone.

“This issue may be compounded if the payment rises in the event of a downturn in cryptocurrency prices,” it states.

Guy Dickinson, former treasurer of HSBC Australia and now the CEO of blockchain carbon trading platform BetaCarbon, is skeptical of the idea that major financial institutions will adopt crypto collateral loans any time soon.

“There will be a handful of pilots at best until there is an established multi-year risk model,” he says.

Even though Dickinson has transitioned into the Web3 world himself and left behind the traditional finance industry, he reckons TradFi institutions won’t take on crypto-collateral loans until protection is available to cover itself.

“Based on my experience as the treasurer of HSBC and the recent experience of how loan providers are proceeding with extreme caution with traditional lending criteria, it is highly unlikely that crypto as collateral would be a scalable, commercially viable option until someone is willing to ‘insure’ the collateral.”

Dickinson says the “crypto asset class is poorly understood” and holds vast complexities for lenders to navigate. 

He points out that the “recent debacles with FTX” encourages bankers to stay away from crypto and “stay in their wheelhouse.”

However, he notes that the concept of using different securities or commodities as collateral is not new.

“If we replaced the word crypto with shares or precious metals, we would be able to move forward under the well-established Lombard lending frameworks commonly used in private banking circles,” he explains. 

Why a crypto home loan went south for Tozoni

Tozoni says that trying to keep afloat with a Bitcoin-backed loan was incredibly stressful.

“Bitcoin continued to decline, and I would keep getting margin calls. So, it’s just many stressful months of having to add more and more Bitcoin and not to lose my other Bitcoin.”

Few assets you could put up for collateral have the potential to plummet in price quite as quickly as Bitcoin, which Tozoni discovered during the COVID-19 pandemic price plunge when the world’s markets started to panic about a potential depression. 

March 12, 2020 – aka “Crypto Black Thursday” – saw the price of Bitcoin drop from $8,000 to $3,600, in a matter of minutes.

“There was a short flash crash [March 12, 2020] where Bitcoin crashed,” he says, explaining that it was a “very short-term crash, where it dove down, and then two or three days later came back up.”

But there was no grace period built into the loan, so everybody’s collateral who went below the margin was liquidated, including Tozoni.

Tozoni is understandably grumpy with the lender, as he believes if they had exercised some patience and “waited three days” until it came back up, he would still be the proud owner of his Bitcoin. 

Adding insult to injury, Parke warns that borrowers can run into more problems than just losing their crypto assets if a margin call is made. They can also face tax consequences if their Bitcoin was worth more than they bought it for. 

He says that while some “lenders offer non-recourse products,” liquidation will likely still trigger a capital gains event while “costing the borrower any future gains.”

Talk about a rough day in the trenches, getting slapped with a big tax bill after losing your Bitcoin collateral.

After Tozoni’s Bitcoin disappeared quickly, he was “stuck with just real estate.”

This might not seem so bad since he at least had something, but it proved to be an extended nightmare for him when his tenants became tight-fisted during the pandemic.

“A lot of tenants did not pay during COVID-19,” he says, explaining that he was trying to liquidate the properties because he was moving but found it impossible to sell a property where “there are tenants unwilling to pay.” 

The values of the properties were diminishing because of it, according to Tozoni.

Some tenants “just disappeared and messed up the property,” so he had additional costs to get things fixed while still hurting from all the lost Bitcoin.

Crypto home loans: The higher the collateral, the better

In hindsight, Tozoni believes he probably should have opted for a higher collateral ratio, to protect himself against a sudden flash crash.

“Three to one, even a four to one [collateral ratio] if you want to be safe,” Tozoni says, as he believes “the worst case scenario” happened to him where his Bitcoin was liquidated at the lowest price before the price shot up again.

“So, even if I were to sell my properties, it [Bitcoin] was already higher than that,” he says.

However, looking back at the whole ordeal, Tozoni has reached a level of peace with the whole situation but still regrets how it played out.

“I was thinking, ‘Finally, this nightmare is over.’ I ended up giving more and more and more and then most of it ended up gone. But then on the other hand, it’s been like a year and a half of just stress, of constantly being drained.”